Another Week, Another Wireless Deal – Part II

Last Friday, perhaps while you were reading our piece Introducing the New Sprint, AT&T announced that it will acquire Leap Wireless, and its Cricket brands, for $1.2 billion. (1) And we can’t shake the irony that when we first introduced SoftBank’s plan to acquire a majority stake of Sprint it came on the heels of the news that T-Mobile and MetroPCS would combine. And, of course, this new AT&T-Leap deal is AT&T’s first sizable acquisition since the Justice Department squelched the company’s $39 billion deal to buy the fourth-largest U.S. wireless carrier, T-Mobile USA, in 2011. (Not that we want to call AT&T’s $780 million dollar purchase of Alltel wireless “puny.”) What’s going on in wireless?

As news of the AT&T-Leap deal broke, the storyline was that AT&T, the nation's second-largest wireless carrier, was aiming to shore up its access to the airwaves it needs to offer mobile service. (2) Jonathan Chaplin, an analyst with New Street Research, said AT&T controls less spectrum in aggregate than either Verizon Wireless or Sprint, and has less spectrum per subscriber than T-Mobile. AT&T’s press release says Leap’s network covers approximately 96 million people in 35 U.S. states. Leap currently operates -- under the Cricket brand -- a 3G CDMA network, as well as a 4G LTE network covering 21 million people in these areas. AT&T also noted that the acquisition includes spectrum in the PCS and AWS bands covering 137 million people and is largely complementary to AT&T’s existing spectrum licenses. Immediately after approval of the transaction, AT&T plans to put Leap’s unutilized spectrum – which covers 41 million people – to use in furthering its 4G LTE deployment and providing additional capacity. Leap CEO Doug Hutcheson noted that some 60 percent of the company's spectrum was not actively being used, much of it in the valuable AWS spectrum range — a block that both AT&T and Verizon started to engage as a way to supplement their existing 700MHz networks as they fill to capacity. In all, Leap owns AWS spectrum in 100 markets, spectrum that AT&T could turn into extra LTE capacity relatively quickly. Cricket already has 11 LTE markets live, covering about 21 million people. [For more on Leap’s spectrum holdings, see A bird’s eye view of the AT&T-Leap Wireless merger]

Joan Engebretson, writing for telecompetitor, noted the late-Friday announcement saying “the potential merger partners might want to minimize the attention paid to the announcement.” Why? AT&T will be selling off Leap’s 700 MHz A-block spectrum in the Chicago market -- “Leap’s 700 MHz A-block spectrum in Chicago is not compatible with AT&T’s network at this point in time,” said an AT&T spokesman. AT&T seems to have deliberately avoided acquiring any A-block spectrum even though that block is adjacent to AT&T’s spectrum holdings in the B-block and lower C-block and, theoretically, should be attractive to the carrier. AT&T has a long-standing dislike for the A-block, claiming that devices capable of operating in the A-block are subject to interference from Channel 51 TV broadcasters. Channel 51 is operational in about 30 of the nation’s 200+ TV markets, including Chicago. Leap paid $204 million for its Chicago A-block spectrum in August 2012 but has not built it out. Under the terms of the AT&T-Leap purchase agreement, Leap shareholders will receive “a contingent right entitling them to the net proceeds received on the sale of Leap’s 700 MHz A-block spectrum in Chicago.” The odds of that license being sold any time soon would appear poor, however. When Verizon Wireless attempted to sell A-block spectrum in numerous markets as a condition of being able to purchase AWS spectrum from the cable companies, Verizon was successful in selling only a small fraction of those licenses.

Carriers have had major issues with A-block spectrum. The FCC recently gave small carriers with A-block licenses additional time to build the spectrum out. Initially small carriers had difficulty persuading manufacturers to build handsets to work in that band because the volumes required were unusually small, considering that no nationwide carrier was deploying service in that spectrum band. Since then U.S. Cellular has obtained some A-block devices, which should make it easier for smaller carriers to obtain the same. But a different problem remains for A-block spectrum holders – how to offer their customers nationwide roaming. Because of the way international standards were established, devices capable of operating in the A-block can also work in the B-block or lower C-block, where AT&T has deployed service. But small carriers say AT&T has refused to allow devices capable of operating in the A-block on its network – even if the devices do not belong to AT&T’s own customers.

The FCC for over a year has been exploring what it might do to enhance interoperability in the lower 700 MHz band and Acting FCC Chairwoman Mignon Clyburn has said more than once that she would like to see the issue resolved. To date the FCC has taken no definitive action on 700 MHz interoperability. But this sure seems like an issue that could find its way into the AT&T and Leap Wireless merger conditions.

Spectrum, though, is only part of the story. Once an afterthought for carriers, dominated by low-end plans and even lower-end phones, prepaid is now one of the hottest segments in wireless. Leap, through its Cricket subsidiary, has roughly 5 million subscribers nationwide. It offers low-cost, no-contract prepaid wireless plans and cellphones. The company has recently struggled to compete in a smartphone world, and in particular, had difficulty selling iPhones on prepaid contracts. Cricket users will now have access to AT&T's 4G LTE mobile network. Meanwhile, AT&T will retain the Cricket brand name and hold on to Leap's own 4G LTE network. AT&T has just started to take prepaid more seriously with the launch of its Aio Wireless brand in a small handful of markets, but Cricket instantly gives AT&T significantly more credibility and reach in the space.

Of course, the transaction is subject to review by the Federal Communications Commission and the Department of Justice. AT&T predicted it will close the deal in six to nine months. But the deal is expected to receive close scrutiny from regulators, who are concerned that U.S. wireless spectrum has become over-concentrated in the hands of market leaders AT&T and Verizon Wireless. If approved, the merger would still leave the U.S. with four national wireless companies. But regulators will need to weigh the apparent benefits of the deal against the possible downsides, including a loss of competition in markets where Cricket does business today, offering all-inclusive voice and data plans that are in some cases significantly cheaper than AT&T's.

Many analysts expected AT&T to look for another acquisition target after a planned buyout of T-Mobile in 2011 fell through. That deal was scrapped after running into opposition from government agencies that said it would create a less competitive wireless industry and potentially lead to higher prices for consumers.

The deal was quickly criticized by Public Knowledge and Free Press, two opponents to consolidation of ownership in the wireless marketplace.

"AT&T already has more wireless capacity than it needs to serve its customers, and it should focus on using what it has rather than continuing to try to buy out competitors," said PK’s Harold Feld. "AT&T needs to stop trying to build market share with mergers and focus on building a better network....The Justice Department and the Federal Communications Commission need to say 'no' to this latest effort by AT&T to buy out its rivals and rebuild 'Ma Cell.'"

Free Press President Craig Aaron said, “After its failed attempt to merge with T-Mobile, AT&T is back again, this time trying to gobble up another competitor in Leap. This is a smaller deal, but AT&T is sure to make the same false claims it tried with T-Mobile about how fewer competitors will be good for wireless customers. But this takeover would result in fewer choices, higher prices and job losses. We urge the Justice Department and the FCC to reject AT&T's latest attempt to swallow a competitor.”

Glenn Manishin, a partner at the law firm Troutman Sanders and a leading antitrust expert, pointed out that the Justice Department intervened in FCC’s spectrum auction proceeding to stress that the FCC should build in safeguards to prevent dominant wireless firms from squeezing out smaller rivals. “Hence, there’s a significant risk that the same competition concern will arise in an antitrust review of the AT&T-Leap deal, as the principal assets being acquired appear to be spectrum licenses rather than end user customers,” Manishin said. Regulators may not view Leap in the same light as, say, T-Mobile, though. It’s hardly nationwide, and it’s struggling. Allowing the acquisition would still maintain the balance between the big 4 operators and only increase AT&T’s customer base by a modicum. But the deal would also put valuable 3G and 4G airwaves into AT&T’s pocket in many regions of the country, giving it the same kind of “surgical” spectrum the MetroPCS acquisition gave T-Mobile. The DOJ and FCC may choose to look at this deal primarily as a spectrum deal, rather than a merger of competitors. Both agencies let Verizon buy up the cable companies’ massive treasure trove of 4G airwaves, though they secured assurances from Verizon it would sell off other spectrum. We might see the same thing happen in an AT&T-Leap deal.

There appears to be consensus among investment analysts that the deal will be approved. But the review could be slowed as regulators look at all of AT&T’s recent acquisitions concurrently. In addition to Leap and the aforementioned Alltel deal, AT&T is also paying Verizon Wireless $1.9 billion for even more spectrum. In some markets, the deals may bring AT&T above the FCC’s thresholds designed to ensure competition by preventing concentrated airwaves holdings. And Leap’s Cricket brand sells to low-income customers, who may be disproportionately affected by Leap’s removal from the market.

As we noted last week, Sprint introduced new unlimited talk, text and data plans aimed at boosting its market share. The move came the same week that T-Mobile introduced a new plan that enables customers to upgrade their mobile phones as frequently as twice a year. Before long, Joan Engebretson wrote on July 12, people may look back on mid-2013 as the point where the balance of power in the wireless market began to shift. In recent years, AT&T and Verizon Wireless have become increasingly dominant, holding the most spectrum and gaining the first (and sometimes the only) access to some of the hottest devices for periods of as long as a year. But that’s starting to change.

T-Mobile’s aggressive discounting already has boosted the company’s prepaid market share and is “poised to do so in post-paid as well,” according to a report issued from influential financial research firm Moffett Research. And now that Sprint has received a cash infusion from Softbank, gained control of Clearwire’s vast spectrum holdings, and begun making aggressive moves such as the unlimited plan announcement, it’s likely to see similar results. The picture of an industry with two “haves” (Verizon and AT&T) and two “have nots” (Sprint and T-Mobile) “simply doesn’t fit anymore, portending a more competitive future,” wrote Moffett Research. “After years of Verizon and AT&T pulling away in network quality, we appear to be poised for a dramatic leveling of the playing field, and one where the two ‘have nots’ will eventually have genuine competitive advantages on at least some dimensions (Sprint on data throughput (3); T-Mobile on data speeds).”

Miriam Gottfried, writing in the Wall Street Journal, went as far as to suggest that the AT&T-Leap deal is AT&T’s defensive reaction to a stronger T-Mobile. She notes that more than 60% of Leap's spectrum resides in a band where T-Mobile has a major presence and AT&T, only a smattering of licenses.(4) Buying Leap thus keeps its highly complementary spectrum out of T-Mobile's hands. “In AT&T taking this leap, hobbling T-Mobile seems the primary goal,” Gottfried concludes. Writing for The Motley Fool, Evan Nie is even blunter in his assessment of the deal: “Buying more spectrum licenses to build up capacity isn't necessarily a bad thing, unless you don't really need it and you're overpaying... like AT&T is.” [For more on AT&T overpaying, see “Analysts: AT&T overpaying for Leap”]

Under the headline “Should you worry about AT&T gobbling up Cricket?” Timothy Lee writes in the Washington Post that AT&T-Leap rekindles a long-running debate about whether the consolidation of the wireless market is good for consumers. John Bergmayer, an attorney at Public Knowledge, argues that the market is already “very top-heavy,” with AT&T and Verizon holding a disproportionate share of the airwaves. Bergmayer argues that spectrum gap insulates the top two from competition from smaller rivals. And he warns that allowing AT&T to acquire Leap will skew the market even further, leading to fewer consumer choices and higher prices.

But Fred Campbell, a former FCC staffer and an analyst at the Competitive Enterprise Institute, disagrees. He contends that Leap’s business strategy, which focuses on providing connectivity to urban customers, has caused Leap to neglect rural markets and under-use its spectrum holdings there. Campbell contends that transferring Leap’s spectrum to AT&T will allow it to be used more efficiently, improving the quality of service for customers of both companies. Campbell also notes that Leap is hobbled by a high debt burden, which will make it difficult to keep its network on the cutting edge. He argues that AT&T’s deep pockets and broad customer base will allow it to use Leap’s spectrum and other assets more efficiently.

Bergmayer doesn’t deny that the merger could allow AT&T to use LEAP’s spectrum more efficiently. But he warns that “those efficiencies may be offset by AT&T facing less downward pricing [pressure] to be passed on to consumers.” In his view, Leap’s presence at the low end of the cellular market forces the larger firms to keep prices down and service quality up. Every time a firm exits the market, those competitive pressures get reduced.

In addition, regulators may need to consider if this relatively small step towards consolidation just leads to the next. The WSJ’s Miriam Gottfried also wrote this week about Dish Network and T-Mobile considering a possible combination. Dish seeks to use the wireless spectrum it has amassed through a partnership with an established national phone carrier. Dish lost the chance at one potential partner last month, when it abandoned efforts to buy Sprint. In light of that, another possibility was for AT&T, which wants more spectrum, to buy Dish. But the Leap offer, the Verizon spectrum deal, the Alltel purchase – maybe that’s too many transactions under regulatory review even for AT&T. For T-Mobile, Leap's spectrum was considered highly complementary. And buying it would have helped the carrier expand its MetroPCS brand to more markets. With Leap now all but locked up by AT&T, T-Mobile may look more favorably at Dish's spectrum stash. Dish's need for a deal may be more pressing than T-Mobile's. The satellite-TV operator has a mandate from the FCC to cover at least 70% of its new network within seven years, having been granted approval earlier this year to use its spectrum for a cellphone network. And while T-Mobile would have benefited from Leap's spectrum, it doesn't have a pressing need for it after buying MetroPCS.

You can track all that’s going on in wireless here and these various mergers and acquisitions here. And we’ll see you in the Headlines.

Notes:

1. AT&T will also be responsible for Leap's $2.8 billion in debt. The Motley Fool estimates the total cost to AT&T at $5 billion.
2. See AT&T's $1.2B bid for Leap is mostly about spectrum (Fierce); AT&T to Acquire Leap Wireless for $1.2 Billion in Cash (WSJ); AT&T to buy Leap Wireless for $1.2 billion (The Hill); What does AT&T's deal to buy Cricket mean to you? (The Verge); and AT&T to buy Leap Wireless for $1.2 billion (USA Today)
3. How much data can be transferred from one location to another in a given amount of time.
4. The Motley Fool notes that Leap's 3G network is built using CDMA, an entirely different and incompatible technology from AT&T's GSM and HSPA network. Ma Bell will now be tasked with integrating Leap's customer base and slowly migrating them to its own network before it can fully repurpose the spectrum it's acquiring, which in itself will take some time.